The Fed Blog

Monday, December 22, 2014

The next blog post will be on Monday, Jan. 5, 2015. We wish you all the best during the holidays and a happy and healthy New Year.

Only a few days ago, investors were starting to doubt Santa Claus. He usually gives us a yearend rally as a Christmas present. However, the S&P 500 plunged 4.9% from December 5 through December 16. That was certainly a lump of coal. But then, the S&P 500 yet again found support around its 50-day moving average without leading to a correction of 10% or more--having done so more than a dozen times since the spring of 2012. Instead, it rallied 5.0% from Wednesday through Friday last week. The S&P 500 is only 0.2% below its record high of 2075.37 on December 5.

Santa had some help from the “Fairy Godmother of the Bull Market,” Fed Chair Janet Yellen. At her press conference on Wednesday, she sprinkled some fairy dust and waved her wand, saying that the Fed will remain “patient” when considering when to raise interest rates, which could still be a “considerable time” away. Whenever she speaks publicly about the economy and monetary policy, stock prices tend to rise. She hasn’t lost her touch!

Finally, investors have good reason to believe in Santa. Since 1928, December has been the best month for stocks, with an average gain of 1.5%. That matches July’s average, but December has been up 64 times and down 22 times, while July has been up 49 times and down 38 times. By the way, the January Barometer is likely to be wrong this year. The S&P 500 fell 3.6% during the first month of this year, but is up nicely ytd, especially if Santa’s rally continues through the end of the year.

Today's Morning Briefing: Melt-Up for the Holidays? (1) Santa’s little helper. (2) From lump of coal to lump of sugar. (3) Transportation stocks on a roller coaster. (4) Yellen’s fairy dust full of good cheer. (5) Yellen claims FOMC members not worried about plunging oil prices, jumping junk yields, or imploding Russian ruble. Or are they? (6) Fed-Speak: Inflationary expectations vs. inflationary compensation. (7) December often stuffs goodies in socks and stocks. (8) A bull market for all seasons. (9) Dr. Ed’s Movie Reviews: 2014. (10) See you next year. (More for subscribers.)

Friday, December 19, 2014

Thank you, Janet Yellen! You didn’t disappoint me. You are still the “Fairy Godmother of the Bull Market!” As I’ve noted many times before, the S&P 500 tends to rise after Yellen speaks about the economy and monetary policy. The S&P 500 soared 4.5% on Wednesday and Thursday in response to the dovish FOMC statement and Yellen’s bullish press conference.

On Wednesday, I wrote:

However, the plunge in oil prices and the turmoil in the junk bond market might increase the likelihood that the Fed will delay the so-called "lift-off" of interest rates beyond mid-2015. "None and done" in 2015 is a distinct possibility for Fed policy. Let’s see what Fed Chair Janet Yellen has to say later today. I’m counting on her to continue to be the "Fairy Godmother of the Bull Market.”

On Tuesday, I wrote, “The FOMC might surprise us and keep ‘considerable time’ in the statement.” I noted that inflationary expectations are falling. I also wrote:

The distress in the junk bond market might also dissuade the FOMC from changing the "considerable time" language. In any case, Fed Chair Janet Yellen’s press conference on Wednesday afternoon could have a big impact on the markets. I’m still betting that she is the "Fairy Godmother of the Bull Market.”

On Monday, I noted that FRB-Chicago President Charles Evans, one of the Fed’s uber-doves, has called on his colleagues to be patient and to delay raising interest rates.

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

The FOMC remains dovish and patient. It will be even more dovish and patient next year when Evans will be a voter. Two of the three dissenters (Richard Fisher and Charles Plosser) were hawks, who are retiring. The FOMC has to be concerned about the financial stresses caused by the plunge in oil prices and the strength of the dollar, as evidenced by the spike in junk bond yields and the selloffs in the bonds, stocks, and currencies of emerging economies. That’s why they are willing to be patient for a considerable time longer.

Yesterday's Morning Briefing: Grand Central 24/7. (1) Fairy Godmother. (2) The FOMC will be even more dovish and patient next year. (3) Evans will get a vote next year, and two hawks are retiring. (4) FOMC clearly concerned about financial instability related to dropping oil prices, soaring dollar, and and rising junk yields. (5) Central banks succeeding in inflating wealth. (6) Their transmission mechanisms to their economies aren’t working so well. (7) Weak data stimulate PBOC to ease and Chinese stocks to soar. (8) ECB’s Coeuré pushing for QE. (9) November crude oil demand drowned in sea of oil. (10) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Thursday, December 18, 2014

We now have November data compiled by Oil Market Intelligence on global oil demand and supply. The data show that world crude oil revenues and outlays, at an annual rate, plunged by $1.1 trillion from June through November, down to $2.7 trillion. OPEC’s revenues are down at an annualized $409 billion over this period.

Global oil demand growth continued to slow. While the 12-month average rose to a record high of 92.8mbd during November, it was up just 0.7% y/y, the lowest since April 2012. The weakness is mostly attributable to the advanced economies of the OECD, where oil demand is down 0.8% y/y, while emerging economies’ demand is up 2.2%.

The big story, of course, is the surge in non-OPEC production in recent months. It jumped 2.8mbd over the past six months through November. It is up 4.4% y/y. That’s forced OPEC to reduce output slightly last month. US and Canadian output rose 1.1mbd over the past six months through November.

I expect that the plunge in oil prices will reduce global production quickly within the next few months, especially in countries with relatively high production costs. We predict that the price of a barrel of Brent will stabilize between $60 and $70 next year.

Today's Morning Briefing: Grand Central 24/7. (1) Fairy Godmother. (2) The FOMC will be even more dovish and patient next year. (3) Evans will get a vote next year, and two hawks are retiring. (4) FOMC clearly concerned about financial instability related to dropping oil prices, soaring dollar, and and rising junk yields. (5) Central banks succeeding in inflating wealth. (6) Their transmission mechanisms to their economies aren’t working so well. (7) Weak data stimulate PBOC to ease and Chinese stocks to soar. (8) ECB’s Coeuré pushing for QE. (9) November crude oil demand drowned in sea of oil. (10) Focus on market-weight-rated S&P 500 Energy. (More for subscribers.)

Wednesday, December 17, 2014

Of course, debt defaults are likely to occur among oil producers. But I doubt they will trigger a financial crisis comparable to what happened in 2008 and 2009. Most of their junk bonds are in bond funds. There could be a liquidity crisis in those funds, but the pain will be limited to very few investors, in my opinion.

The cost to insure Russia's five-year bonds has surged to the highest levels since 2009, reflecting fears related to the fact that the Russian government gets half of its revenue from oil and gas exports. Moscow has significant foreign exchange reserves to service its debt. So far, the ratings agencies aren't downgrading Russian government debt. Standard & Poor's reaffirmed Russia's credit rating in October, though it warned of a downgrade over the next 18 months if the government's finances deteriorate.

Venezuela, on the other hand, is in dire straits. Oil makes up 96% of the country’s export earnings, and it stands to get squeezed more because its oil production costs are relatively high. Venezuelan credit default swaps cost five times more than they did in June.

The Bank of America Merrill Lynch high-yield corporate bond composite rose to yield 7.13% on Monday, up 197bps from the year’s low of 5.16% on June 23. The spread over 10-year Treasuries rose to 501bps on Monday, up from the year’s low of 253bps on June 23. That’s the widest since November 20, 2012. This spread is highly correlated with the S&P 500 VIX, which rose to 23.6 yesterday, still well below levels during the current bull market’s previous panic attacks.

Yesterday’s FT featured a story titled, “Oil plunge sparks US credit market fears.” It focused on collateralized loan obligations (CLOs). These “are a type of bond that bundles together cash flows from loans made to highly indebted companies and then slices them according to risk. … Oil and gas loans make up 4.5 per cent of the S&P LCD Loan index by amount outstanding-a proxy for exposure that may be embedded in CLOs. Energy loans make up 4.1 per cent of JPMorgan Chase’s loan index.”

Tuesday, December 16, 2014

Falling oil prices along with the slow pace of global economic growth are weighing on analysts’ estimates for S&P 500 revenues and earnings. They’ve lowered their revenue growth rates for 2014 and 2015 to 3.4% and 3.0% as of the week of December 4. At the beginning of October, when the price of oil was just starting to crash, they were predicting 3.9% and 4.2%.

Their estimates for earnings growth were 7.9% and 12.4% for this year and next year at the start of October. Now they are estimating 7.0% and 9.3%. They’ve slashed their estimate for Q4-2014 by 6.5% since then down to $29.91, slightly below Q3’s $30.06. That’s the S&P 500’s biggest decline since Q1-2009. Most of these downward revisions are attributable to the slashing of revenues and earnings estimates by energy industry analysts.

Monday, December 15, 2014

With the benefit of hindsight, it now appears that the energy boom of the past few years might have been a bubble, not just in the US, but worldwide. Booms have a tendency to turn into bubbles when they attract too much equity and debt capital, which leads to excess capacity. When the bubbles inflate, so do the prices that attract all the capital. When the resulting excess capacity leads to falling prices, the bubble bursts as capital dries up. The key characteristic of tulip and other bubbles is expectations that tulip prices will continue to rise even as more tulips are produced.

During the second half of the 1800s, we had the railroad boom in the US. During the early 1900s, the booms were in autos and appliances. The Great Depression ended with the defense spending boom of World War II. During the 1950s and 1960s, the expansion of the highway system stimulated the growth of suburbs. The resulting housing boom ended in a big bust at the end of the previous decade. The IT revolution stimulated the US economy during the 1990s. The energy industry was energized by the technological revolution, resulting in the fracking boom.

Again, with the benefit of hindsight, it now seems that the fracking boom was a bubble financed by investors desperately seeking better returns available from high-yield bonds issued by energy companies and countries. The chart of US plus Canadian oil production looks a bit like the chart of asset-backed commercial paper outstanding prior to the financial crisis of 2008.

The high-yield bond market has been hard hit by the sudden risk aversion of investors, particularly those who bought energy-related bonds. Many have been seeking safety in lower-yielding US Treasuries. The Bank of America Merrill Lynch US high-yield corporate bond yield rose from the year’s low of 5.15% on June 24 to Friday’s 7.04%, the highest since July 27, 2012. The spread over 10-year Treasury yields widened over this period by 237bps from 257bps to 494bps.

Today's Morning Briefing: The Energy Bubble. (1) Worrying about the Middle East in the Midwest. (2) Too much of a good thing? (3) US consumers are happy shoppers. (4) Widespread shopping spree. (5) Consumers of last resort. (6) Definition of a bubble fits oil’s boom/bust. (7) High-yield market highly stressed. (8) Capital is drying up for drillers. (9) Submerging oil economies. (10) Fed in 2015: None and done? (11) Can US offset all the rest? (12) Iranian surrogates threatening Saudis. (13) Still bullish. (14) Focus on market-weight-rated S&P 500 Retailers. (More for subscribers.)

Thursday, December 11, 2014

In the 11/17 Morning Briefing titled “The Great Deflators,” I wrote about zombies: “In their effort to moderate the business cycle, central bankers have a tendency to keep zombies alive. These are the ‘walking dead’ business borrowers, who borrowed too much and are hemorrhaging cash. They need to die and should be buried. Instead, easy money keeps them in business, allowing them to continue producing more with their excess and unprofitable capacity. Today, China is full of zombies. There are plenty in the global mining industries.

“If you look hard enough, you’ll find zombies just about everywhere. It certainly would be easier to spot them if central banks started to tighten their monetary policies. That might explain why central banks aren’t likely to do so. Deflation may be the most telling sign of the zombie problem. By fighting deflation, the central banks are keeping the zombies alive!”

On November 21, the People's Bank of China (PBOC) cut its benchmark one-year loan interest rate to 5.6% from 6.0% and cut its benchmark one-year deposit rate to 2.75% from 3.00%. The nation's central bank also hiked the upper limit on deposit interest rates to 1.2 times the benchmark rate from 1.1 times the benchmark rate. The bank said it took the unexpected actions, which were the first such changes since July 2012, in response to expensive borrowing costs rather than any direct worries about the economy's slowdown.

Who are they kidding? Obviously, the PBOC is worried about slowing growth and persistent deflation. However, there they go again keeping zombies alive. They also triggered a mini-bubble in the stock market, as I discussed yesterday.

Wednesday, December 10, 2014

Late on Monday, China’s securities clearinghouse banned investors from using low-grade corporate bonds as collateral for short-term financing. The move is part of Beijing’s structural reforms aimed at shoring up the financial system.

The Shanghai Composite dropped 5.4% to 2,856.27, suggesting that the recent stock bubble may be bursting already. The retail-dominated market is still up 35% this year. The Chinese have a huge savings rate. They’ve cooled off to putting their money into properties and wealth-management products. Instead, they’ve been pouring funds into the stock market. Yesterday’s FTreported: “The balance of outstanding margin loans has risen more than two-thirds since the beginning of September, to Rmb575bn, by the end of last week. Banks were themselves among the worst fallers on Tuesday with the financial sector off 7.6 per cent while energy shares dropped 7.4 per cent.”

The 7/11 WSJreported that “China's banking regulator imposed fresh requirements on banks to keep their wealth-management product business in check, in another step to tighten its grip on a once-loosely regulated part of the shadow-banking business.” Banks must separate their wealth-management product business from retail lending business by setting up separate accounting, statistical analysis, risk management and performance appraisal systems...” Banks had until the end of September to complete the setup of the independent wealth-management departments.

Wealth-management products have been popular because they offer higher yields than deposits. But they are obviously risky. The WSJ reported that over 400 banks had a total of 13.97 trillion yuan ($2.25 trillion) in outstanding wealth-management products at the end of May.

The more fundamental problem in China is that the economy may be slowing faster than widely recognized. Last Wednesday, I reviewed the country’s imports data through October. November data were released on Monday showing that imports remain flat this year, using the 12-month moving average. That’s mirrored in China’s imports from Australia, Brazil, Japan, Taiwan, and the US. Only imports from the European Union and South Korea remain on uptrends, though they started to look toppy in November.

Today's Morning Briefing: Downsides In 2015. (1) From the upbeat scenario to the downbeat risks. (2) The bull is still prone to mood swings. (3) “Considerable time” is running out of time. (4) Yellen’s 6-month horizon. (5) More upbeat labor market indicators. (6) Next Fed QE in corporate bonds? (7) Is China’s mini-bubble bursting already? (8) China’s imports showing no growth all year. (9) Draghi renews his vows to do whatever it takes. (10) Greeks breaking plates again. (11) Will there be blood in the oil patch? (12) Oil majors vs. frackers. (13) The Russian bear is wounded. (14) The jury is still out on Abenomics. (More for subscribers.)

Tuesday, December 9, 2014

According to the WSJ yesterday, the IMF is raising its forecast for US growth next year to 3.5% from its last estimate of 3.1%, partly because of expected lower energy costs. The nearby futures prices for gasoline and heating oil are down 45% and 33% from their summer highs. Last year, consumers spent $371 billion on gasoline and $27 billion on heating oil. So they could save a total of about $175 billion, or $1,510 per household at an annual rate.

Payroll employment gains have averaged 227,830 per month during the 12 months through November, up from 205,100 per month last November, and the most since March 2006. Inflation-adjusted wages and salaries in personal income rose 2.9% y/y to a record high during October. As I showed yesterday, our Earned Income Proxy suggests that they continued to rise sharply during November.

Monday, December 8, 2014

As I do every month, I cut to the chase when analyzing the employment report by calculating our Earned Income Proxy, which is highly correlated with both private-sector wages and salaries as well as retail sales. Our proxy is simply the average workweek times payrolls times average hourly earnings in the private sector. It jumped 1.0% m/m during November as the workweek rose 0.1 hours, payrolls jumped 314,000, and wages rose 0.4%.

Revisions have added 44,000 jobs to the preliminary estimates for September and October, now showing gains of 271,000 and 243,000, respectively. During the first 10 months of this year, nine of the months were revised higher.

Some cranky observers question November’s strength, noting that it might have been boosted more than usual by seasonal workers in retailing, transportation, and warehousing. Others question the seasonal adjustment factor. Then again, odds are that November’s number will be revised higher anyway.

What about wages? November’s 0.4% m/m increase was the best monthly gain since June 2013. However, it remained stuck around 2% on a y/y basis. So far, upward pressures seem to be building up only in construction (2.5%) and leisure & hospitality (3.6). Manufacturing (1.1) remains remarkably moderate. Retail trade (2.3) and wholesale trade (2.5) are in line with the average trend. Financial services (3.8) and transportation and warehousing (2.9) are relatively high, while natural resources (1.4) and educational & health services (1.6) are relatively low.

Thursday, December 4, 2014

Does low inflation justify higher valuation multiples? There are many valuation models for stocks. They mostly don’t work very well, or at least not consistently well. Over the years, I’ve come to conclude that valuation, like beauty, is in the eye of the beholder.

For many investors, stocks look increasingly attractive the lower that inflation and interest rates go. However, when they go too low, that suggests that the economy is weak, which wouldn’t be good for profits. Widespread deflation would almost certainly be bad for profits. It would also pose a risk to corporations with lots of debt, even if they could refinance it at lower interest rates. Let’s review some of the current valuation metrics, which we monitor in our Stock Market Valuation Metrics & Models:

(1) Reversion to the mean. On Tuesday, the forward P/E of the S&P 500 was 16.1. That’s above its historical average of 13.7 since 1978.

(2) Rule of 20. One rule of thumb is that the forward P/E of the S&P 500 should be close to 20 minus the y/y CPI inflation rate. On this basis, the rule’s P/E was 18.3 during October.

(3) Misery Index. There has been an inverse relationship between the S&P 500’s forward P/E and the Misery Index, which is just the sum of the inflation rate and the unemployment rate. The index fell to 7.4% during October. That’s the lowest reading since April 2008, and arguably justifies the market’s current lofty multiple.

(4) Market-cap ratios. The ratio of the S&P 500 market cap to revenues rose to 1.7 during Q3, the highest since Q1-2002. That’s identical to the reading for the ratio of the market cap of all US equities to nominal GDP.

Wednesday, December 3, 2014

I’m an economist by training. I’ve seen pictures of oil rigs, but never seen one up close. As an economist, I have a tendency to use seasonally adjusted data to analyze the economy. For example, on my website I have a publication titled, “US Petroleum Weekly.” It shows data compiled by the US Department of Energy (DOE) for domestic production and usage, as well as exports and imports. I’ve been using the seasonally adjusted series rather than the unadjusted data compiled by DOE.

One of our accounts noted that the seasonally adjusted production numbers show a decline of 0.4mbd over the past 10 weeks through the week of November 21 to 9.0mbd, while the unadjusted data continued to rise by 0.3mbd to 9.1mbd. The former suggest that the plunge in oil prices may be depressing production already, while the latter suggest that’s not so. The unadjusted data for the key oil-producing states, especially Texas and North Dakota, show production still rising.

I will continue to monitor usage as well as exports and imports on a seasonally adjusted basis. However, I will focus on the unadjusted data for production to assess whether the drop in oil prices is depressing US oil field output. For now, my conclusion is that the US oil industry intends to play the Saudis’ game of chicken.

Tuesday, December 2, 2014

Could it be that the plunge in oil prices isn’t just attributable to a supply glut? Perhaps the global economy has turned much weaker since the summer than widely recognized. The Eurozone’s recovery since the summer of 2013 has been very weak. The sanctions imposed on Russia during the summer of this year seem to have hurt lots of businesses in the Eurozone. China’s anti-corruption drive has depressed demand for luxury properties and high-end consumer goods among the country’s elite. And now the plunge in oil prices will depress spending by oil-rich countries. Let’s have a look at some of the key global economic indicators before turning to a more detailed analysis on a country-by-country basis:

(1) Industrial commodity prices. So far, the plunge in the price of a barrel of Brent hasn’t been reflected in a comparable drop in the CRB raw industrials spot price index. This index has been range-bound since the start of 2012 between 495 and 550. It is currently at the bottom of that range with a reading of 505.

(2) Copper price. On the other hand, the price of copper, which is a component of the CRB raw industrials spot price index, fell sharply last week, posting the longest string of readings below $3.00 since the summer of 2010.

(3) Emerging markets. As I noted yesterday, the Emerging Markets MSCI stock price index continues to track the range-bound CRB raw industrials spot price index. It hasn’t plunged along with oil prices or in response to the stronger dollar, so far.

(4) Global M-PMI. Yesterday, Markit reported that global manufacturing production “expanded at the slowest pace for 15 months in November, as growth of new orders hit a 16-month low and the trend in international trade volumes stagnated.” Output rose for the 25th consecutive month, but the rate of expansion was the lowest since August 2013. The press release stated that some of the weakness was attributable to “stagnation in China.”

Today's Morning Briefing: Slippery Slope. (1) Too much supply, or weakening demand? (2) Negative and positive knock-on effects. (3) Clash of the Titans in the oil patch. (4) US frackers could be more resourceful than Saudis expect. (5) From peak oil to cheap oil. (6) Yergin’s upbeat story for lower oil prices. (7) Getting more cash to drill into the ground will be challenging. (8) Other global economic indicators suggest oil plunge is a supply issue rather than a demand one. (9) Survey of global economies is a mixed bag, with US standing out. (More for subscribers.)

Monday, December 1, 2014

I calculate that world oil revenues peaked this year at an annualized rate of $3.8 trillion during June. I do so by multiplying monthly global oil demand (in millions of barrels per day) by 365 days and by the price of a barrel of Brent.

The 40% drop in the price of Brent since June reduces those revenues by a whopping $1.5 trillion at an annual rate. Those losses are staggering and are bound to depress global capital spending by the oil industry and reduce the availability of cash to finance fracking in the US. In other words, low oil prices will eventually be the cure for low oil prices.

I calculate that OPEC’s revenues peaked this year during June at an annual rate of $1.5 trillion based on the cartel's actual monthly output. Saudi Arabia’s revenues also hit this year’s high during June, at $391 billion. The 40% drop in the price of Brent reduces the revenues of OPEC and Saudi Arabia by $590 billion and $160 billion, respectively, at an annual rate.

For oil users, falling oil prices are a huge windfall, which is equal to the drop in global oil revenues. In the US, I calculate that the current annualized windfall--since June and based on the 40% drop in oil prices--amounts to $291 billion. In Western Europe, it amounts to $221 billion, or €163 billion. In Asia and Latin America, I calculate windfalls of $484 billion and $107 billion, respectively.

Follow this blog by email

Search

Translate

ABOUT: Dr. Ed Yardeni is the President and Chief Investment Strategist of Yardeni Research, Inc., a provider of independent investment strategy and economics research. This blog highlights excerpts from our research service, which is designed for investment and business professionals.

CHART ROOMS

Please see our new and improved website which works great as an app too!